The British Columbia technology sector has grown to become a significant driver of economic growth in Canada. The path to its success has required significant investment, and increasingly private equity firms are deploying capital to promising small and medium-sized enterprises (SMEs) in recognition of the compelling investment opportunities.
According to the Canadian Venture Capital & Private Equity Association, 70 per cent of Canadian private equity transactions were below $25 million. At FAX Capital, our investments in technology SMEs fall within this range and we seek majority or significant minority ownership so that we can be a meaningfully partner to help businesses reach their full potential.
If you’re a small business owner looking to raise capital to grow and are considering private equity as a source of capital, then these three insights will help you decide and prepare.
Minority vs. majority positions
This is the most fundamental question to answer – how much of your business do you want to sell? Control is the primary consideration because a private equity investment of any size will include mechanisms that give new stakeholders a louder voice in the future of the business.
For owners that give up a majority stake to a new investor, while they can retain some governance and decision rights, ultimately they will no longer be in control of their company’s destiny. This can be difficult for some who have spent a lifetime building a business. The good news is that selling a majority stake comes with a control premium; buyers are willing to pay more for control. Owners looking to retire frequently choose this path.
At the other end of the spectrum are owners that sell a minority stake in their business, which is becoming increasingly prevalent in the technology sector with the advent of growth equity investors. This can be an attractive option for owners because they retain control while receiving a cash injection and higher valuation for their business. But even selling 10 per cent of a business can impact the ability of a founder to control a company’s future. Institutional minority investors would often ask for governance, decision rights and liquidity mechanisms which may introduce conflicts with the long-term goals of a founder/owner.
Sellers have a wide range of options and should put a lot of effort into thinking this through in order to secure the right partner and deal structure.
The due diligence process and what to expect
The amount of work involved at this stage in a sale is often underestimated.
A large component of any due diligence process is a detailed financial review of the company, such as validating financial statements, evaluating quality of earnings, determining the capital needs of the business, and reviewing its tax position. Due diligence lists typically include hundreds of questions which are borne by the finance and accounting team, and in the case of smaller companies, by a single person – the financial controller.
Technology companies have additional due diligence requirements including reviewing code, cybersecurity audits, ensuring the right licences are procured, a review of intellectual property rights, privacy policies, contracts and customer lists.
It is possible to make life a little easier for yourself by taking these two steps. First, ensure the company’s books and records are as up-to-date and complete as possible; this will save you a lot of time and money. Second, I encourage business owners to hire an independent advisor to actively manage this stage of the process so the executive team can continue to focus their attention on operations without too much distraction.
What happens after the transaction is complete?
The level of continued involvement from vendors varies, but even owners who sell 100 per cent of their business are frequently required to serve as a consultant for a year or two ensuring the new buyer has continued access to valuable institutional knowledge.
Ultimately, it depends on what you want to achieve. A good private equity partner can help transform the business and accelerate growth.
For example, FAX Capital recently acquired 78 per cent of Carson, Dunlop & Associates Ltd., a home inspection software and education company, partnering with the founder who remains a significant equity owner. FAX’s involvement has included appointing a proven operating executive to help lead the business and to spearhead a digital transformation that will help it evolve into the emerging property-technology space.
Helping transform and scale a business is what can make private equity an ideal partner for many owners that are unable or unwilling to do it themselves. Outside of financial resources, private equity investors also provide an injection of intellectual capital. Leadership at private equity firms come with deep domain expertise and can help identify unique applications of your product or service, opening new revenue streams in the process. They also bring an expanded professional network that includes bankers, new customers and other business leaders who can help produce synergistic outcomes.
Private equity capital isn’t for all owners looking to grow, but those who understand and choose to pursue it can find a good fit with a long-term partner that can help drive significant value creation in their business.